Infilling Station

August 19, 2014

The story of Houston, Texas has added some exciting new chapters in recent years. With low unemployment, a booming economy and one of the fastest-growing populations of any city in the nation, Houston’s rise alongside some of the most prominent cities in the nation continues unabated. Trailing only New York, Los Angeles, and Chicago in size, Houston’s growing influence as a cultural and financial icon has made it a player on the national and international stage.

The evolution of Houston’s retail development landscape is an important part of that story, a reflection of the literal and figurative development that is driving the city forward. In Houston’s Mission: Control, we explored the rapidly changing Houston grocery market, noting the entry of several new grocery concepts and discussing the significance of ongoing grocery segment changes. In American Melting Pot, the second article in the series, we discussed the growing social and economic influence of the city’s sizable Hispanic population, exploring how retailers are evolving to meet the needs of this booming demographic. In this, the third and final installment chronicling Houston’s retail development evolution, we will look at how these big changes are leaving their mark on the cityscape with new and emerging patterns of urban infill. These infill trends are not only leaving a mark on Houston today, but will continue to resonate across the city’s civic and development landscapes for many years to come.

Value added?

Perhaps the most noteworthy retail development trend in Houston today is the explosion of multifamily and office development. Those sectors—especially the residential market — are as robust as they have been at any time since 2005 or 2006. On the flip side of the development coin, urban retail development is essentially stalled — or is, at best, treading water.

Houston’s economic resilience has not only lessened the impact of the last recession, but has made the post-recessionary development climate extremely favorable. Developers are understandably predisposed to maximizing value at a time when the right project can deliver positive spreads. The ability to “go vertical” for residential and office projects, combined with low exit caps and other economic factors, allows those concepts to make economic sense where single level retail projects do not.

Retail reluctance

As long as the multifamily market stays strong, retail seems likely to experience difficulty getting any real traction in the competitive development market in Houston’s urban core. In the near term, Houston’s multifamily housing development boom has simply left retailers with the short end of the stick. As new residential and office projects rise across the city’s urban core, landlords are increasingly reluctant to give retailers long-term leases. Today, not only are rents high and tenant improvement allowances relatively modest, but also, with landlord’s desire to maintain their ability to cash-in on the highest and best use of their properties in the not-too-distant future, long-term deals in projects with any redevelopment potential are rare.

The recent tenant turnover experiences at Houston’s River Oaks Shopping Center — one of the city’s oldest and most venerable shopping centers — is emblematic of the dynamic currently taking place across the broader Houston market. The center has added some structured parking and additional two-level retail in recent years (creating density on the site that was not there before), but when a longstanding restaurant tenant recently closed its doors, prospective retail tenants were offered a short-term, high rent deal—preserving landlord options and giving them the flexibility to redevelop in a few years.

As long as there is demand among office and multi-family developers, seeing one- or two-level retail as a temporary stopgap solution, retailers seem likely to continue to face steep rates and comparatively shorter and less favorable terms.

Boom or…boon?

To get a sense of how impactful Houston’s urban residential explosion has been, consider the extraordinary fact that, as of today, there are more than 60,000 units of multifamily residential in the development pipeline — a figure that accounts for more than 200 new projects. That development is being driven by trends that are by no means unique to Houston, primarily the influence of Millennials and the renewed interest in moving “back” to the city. The impact of those trends has been particularly noteworthy in Houston, however, where the residential growth inside the inner loop is at a level that has not really existed since the 1800s.

Savvy market watchers familiar with Houston are beginning to get the sense, however, that there is so much multifamily and office property already built—and so much currently in the pipeline — that the possibility of market saturation might be on the horizon. It will not happen tomorrow, or even this year, but this level of focused development can only continue for so long before a new pattern emerges. In the meantime, owners and developers will likely continue to ride the residential infill wave to maximize value on parcels they feel might be undervalued or underappreciated.

The future of retail

For now, Houston’s urban core finds itself in a strange spot: development in the Inner Loop is thriving, but remains focused on specific products to the detriment of retail projects. While there is an argument to be made that the fast-growing urban population will ultimately “create” a market for more retail down the road, it is unlikely that the real estate fundamentals and market dynamics of Houston’s urban core will be conducive to significant additional retail.

The reality is that the area inside Houston’s Inner Loop already has a significant amount of retail density — you would be hard-pressed to identify an area in Houston’s urban core that is truly under-retailed. For the foreseeable future, the most significant new retail projects will continue to be siphoned off to the city’s fast-growing suburbs. The probability of more retail opportunities opening up is increasing — but it will take some time. And it may not happen in traditional or expected ways: developers and retailers alike will have to adapt and be creative, utilizing less formulaic design and development solutions like multilevel retail, more structured parking and retail components integrated into an office product.

In the short-term, Houston’s flourishing economy will continue to spur significant amounts of residential and office development in the city’s urban core. While trepidation about long-term leases may keep some retail deals from getting done in the near term, Houston’s meteoric rise will keep the city’s dynamic and evolving retail development landscape moving forward.

Co-authored by Jason Baker and Kenneth Katz, co-founders and principals with Houston-based Baker Katz, an X Team International partner and full-service commercial real estate brokerage firm specializing in retail tenant representation, investment sales, and project development and leasing. To learn more, visit Bakerkatz.com.

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